Abstract: This paper aims to fill part of this gap by modeling the links between household-debt dynamics and China’s macroeconomic fluctuations in a quantitative general equilibrium framework. We present three main findings. First, with a relatively low housing risk aversion, residents’ marginal utility of housing services decreases slowly with the increase of credit-driven housing demand, which keeps the households’ demand for housing strong. As a result, an expansion in household debt raises the house price, which in turn promotes the further expansion of household debt through the collateral channel, forming a positive closed-loop feedback mechanism between household debt and housing prices. Second, through the housing price channel, a rise in household debt makes credit-constrained households reduce consumption, and stimulates constrained commercial banks to allocate more credit to the unproductive household sector instead of entrepreneur sector, crowding out corporate investment. Third, the pro-cyclical bank balance sheet leads to the higher the loan-to-value ratio of households, the larger fluctuations in household debt and macro-economy. This result implies that depressing the leverage of households can curb the expansion of household debt, and stabilize the aggregate economy and housing market.

Keywords: Household Debt; Housing Price Channel; Business Cycle; Financial Frictions